What’s an Ideal Debt-To-Income (DTI) Ratio for a Mortgage?
When applying for a mortgage, you will undergo a financial assessment to determine what you can comfortably afford when purchasing a home. Part of this assessment will be determining your debt-to-income (DTI) ratios. These ratios consider your projected household expenses and current debts against your income to determine if you have the financial means to carry a mortgage.
Key Takeaways
What’s a Debt-To-Income Ratio?
Debt-to-income ratios, or debt service ratios, are expressed as a percentage and compare your debts to gross income. The lower your debt-to-income ratios, the less debt you have compared to your income, while the higher your ratios, the more debt you have compared to your income.?
Lenders use these ratios to assess your ability to repay a loan and manage debt. Debt-to-income ratios have two components: gross debt service (GDS) and total debt service (TDS).?
GDS calculates the expected monthly household debts against your pre-tax income. This includes stress-tested mortgage payments, property taxes, heating, and, if applicable, 50% of condo (strata) fees.?
TDS calculates the expected monthly household costs plus your current monthly debt payments against your pre-tax income. This includes payments made to monthly credit cards, lines of credit, personal loans, car loans and leases, child and spousal support, and student loans.?
Calculating Debt-To-Income Ratio
Calculating your DTI ratios requires you first to add up your expected monthly household debts against your income to determine your GDS ratio. For example, if you have a combined household income of $150,000 and are considering purchasing a $500,000 condo with a 20% downpayment at an interest rate of 5.09%, your monthly mortgage payments would be approximately $2,347 over a 25-year amortization.?
However, as you’ll need to be stress tested to qualify, your qualifying mortgage payment will be 2,823.92 based on your qualifying rate of 7.09%. Annual property taxes are estimated at 1%, heating costs are estimated at $100 a month, and condo fees are $500.?
GDS = (Monthly Mortgage Payment + Monthly Property Taxes + Monthly Heat + 50% Condo Fees) / Monthly Income
Monthly Mortgage Payment – $2,824
Monthly Property Taxes – ($500,000 x 0.01) / 12 = $416.67
Monthly Heat – $100
Condo Fees – $500 / 2 = $250
Monthly Income – $150,000 / 12 = $12,500
GDS = ($2,824 + $416.67 + $100 + $250) / $12,500
GDS = $3,591 / $12,500
GDS = 0.287 x 100 = 28.70%
Knowing your GDS, you can calculate the TDS more easily. In addition to the expected household expenses, you have a line of credit with a $200 monthly payment, a car loan with a $300 monthly payment and a student loan with a $200 monthly payment. Although your qualifying mortgage payment is higher, that’s not the amount you’ll pay when your mortgage funds.
TDS = (GDS Debts + Current Debts) / Monthly Income
GDS Debts – $3,591
Current Debts – $200 + $300 + $200 = $700
Monthly Income – $12,500
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TDS = ($3,591 + $700) / $12,500
TDS = $4,291 / $12,500
TDS = 0.343 x 100 = 34.30%
Ideal Debt-To-Income Ratio for Mortgages
Ideally, the lower your debt-to-income, the more likely you will be approved for a mortgage. Since these ratios indicate your ability to repay debt, you may not qualify for a mortgage if they are too high.?
Maximum Debt-To-Income Ratio for Mortgages
Maximum limits vary depending on the lender and whether your mortgage is default-insured. Typically, for gross debt service ratios, lenders will accept a maximum of 32% for an uninsured mortgage and 39% for an insured mortgage. For total debt service ratios, lenders typically accept a maximum of 40% for uninsured and 44% for insured mortgages.?
How Do I Lower My Debt-To-Income Ratio?
There are some ways you can lower your debt-to-income ratios to make it easier to qualify for a mortgage.?
DTI and Credit Score
Your credit score can impact the DTI ratios your lender will use when qualifying you for a mortgage. Generally, the lower your credit score, the lower your qualifying ratios will need to be to secure a mortgage. If you have good or excellent credit, your qualifying ratios can be higher as long as they don’t exceed the maximum allowable based on your lender’s requirements and type of mortgage (insured or uninsured).?
Note: Consider how debt service ratios can differ on subprime mortgages to improve your chances of qualifying for a mortgage with higher DTI ratios. Gaining insight into these ratios can assist you in navigating the mortgage strategy that best meets your unique needs.?
Final Thoughts
When applying for a mortgage, your debt-to-income (DTI) ratios are crucial in determining your ability to manage and take on more debt. These ratios measure how much of your income will be used to cover debt and mortgage payments, allowing lenders to better understand your financial situation.?
Lenders use GDS and TDS ratios to assess your capacity to take on a mortgage and your likelihood of making timely repayments. If your DTI ratios are too high, you may only qualify for a mortgage if you work toward reducing your current debts.?
Speak with nesto’s mortgage experts today to help you better understand your borrowing capacity.?
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?? This report first appeared on nesto's blog: https://www.nesto.ca/mortgage-basics/whats-an-ideal-debt-to-income-ratio-for-a-mortgage/